New U.S. derivatives bill addresses end user concerns

By Kevin Drawbaugh and Christopher Doering
WASHINGTON, Oct 9 (Reuters) – The chairman of the U.S. House of Representatives Agriculture Committee on Friday unveiled a draft bill on regulation of over-the-counter derivatives that differs in some key respects from bills drawn up elsewhere in the House and by the Obama administration.

The release of Democratic Representative Collin Peterson’s bill means the House now has all the pieces in place for final decision-making on one of the most complex components of a broad plan for reshaping U.S. financial regulation.

With the House Financial Services Committee set to vote next week on its bill, Peterson said his panel’s legislation attempts “to reflect the concerns of end users while bringing oversight and transparency to OTC trading.”

The largely unregulated, $450 trillion OTC derivatives market includes credit default swaps, which are used to bet on whether a company will default on its bonds and have been widely blamed for amplifying the severe financial crisis last year that hammered economies worldwide.

President Barack Obama has proposed new rules for the market involving both the Commodity Futures Trading Commission, overseen by Peterson’s committee, and the Securities and Exchange Commission, overseen by the financial services committee chaired by Representative Barney Frank.

The two panels have been negotiating for months to find legislation that both can agree on, amid heavy lobbying by major banks that reap huge profits from OTC derivatives and by companies that use them to hedge commercial business risks.

Four large banks control over 90 percent of the U.S. derivatives market: JPMorgan Chase, Goldman Sachs, Bank of America and Citigroup.

Derivatives are also used by companies ranging from airlines to agribusinesses to protect themselves from the risk of price movements and other changes affecting their operations — such as the price of fuel and other commodity prices.

The Obama plan has been attacked by industry critics as too ambitious, while some regulators said at a committee hearing this week that Frank’s bill was too weak.

The basic thrust of all three bills is to bring accountability to a high-flying market by forcing more over-the-counter derivatives trading onto exchanges or equivalent platforms. Increased use of central clearinghouses that mutualize risk and increase transparency is encouraged, as is more reporting on the terms of contracts and trading.

STANDARDIZED VERSUS CUSTOMIZED
Exactly how all this is carried out will greatly depend on whether a derivative contract falls into the “standardized” or “customized” category and what rules are imposed on each.

For instance, Obama’s bill would require that all standardized contracts be traded on regulated platforms, while the Frank bill makes this optional. The Peterson bill walks a middle line, forcing some onto exchanges and exempting others. It allows trading exemptions if no regulated exchange or alternative swap execution facility will list a swap.

By one estimate, 60 percent to 80 percent of OTC derivatives are standardized.

In another difference with possible international impact, Peterson’s bill includes foreign exchange in the definition of a swap. The Frank and Obama bills do not.

A House Agriculture Committee aide said the Peterson bill expands on legislation introduced earlier this year by focusing more on regulation of swap participants.

Peterson “is hopeful that the definition is strong enough that it … excludes the commercial end users,” the aide said.

It is important that there is “a clear line between the commercial end users and the large banks,” he said.

The Peterson bill also says the government cannot impose margin requirements on end users. Under the Treasury proposal and the financial services measure they would have that power.

Peterson’s bill attacks excessive speculation in regulated markets by allowing the CFTC to set position limits on future contracts for physically deliverable commodities and redefines eligibility for hedge exemptions and exceeding the limits.

Frank’s financial services committee has set a working session beginning on Wednesday for OTC derivatives legislation as part of a broad effort to reform U.S. financial regulation.

House leaders have said they expect a floor vote next month on a broad financial regulation reform bill. The Senate has moved more slowly on the matter. While it may have legislation before year-end, a floor vote may not come until early 2010.